Allstate: Are we in good hands?
Are homeowners insurers willing and able to underwrite climate change risk, or will individuals bear this risk alone?
Can Allstate deal with climate change?
Allstate, the second largest provider of homeowners insurance in the U.S., is in the business of pricing risk.1 Allstate’s business model is simple: Allstate collects cash today (premiums) in exchange for cash tomorrow (coverage) in case of an unfavorable event to one’s home. Homeowners insurance is a large, competitive market, with premiums totaling ~$85Bn in the U.S. in 2015.2
Given the timing difference between premiums collected today and future payouts for home damage, insurers must price their policies based on what they expect to pay out over the policy’s life (typically a one-year period). To do this, insurers have sophisticated statistical models to price the risk they bear, but the basic approach is to estimate next year’s expected losses using some weighted average of the last several years of historical data.3 The fundamental issue with these models (and any statistical model, really) is they rely on the future looking similar to the past to produce robust results.
Enter climate change, a phenomenon that is likely to lead to increased severity of weather patterns, as well as just a fundamentally different distribution of weather scenarios versus what has been observed in the past.4 A core competency of any insurer is its statistical risk pricing models, which hinge on the relevance of past experience to be indicative of the future. As an insurer in a changing world, how do you account for not only the uncertainty of future weather patterns, but also your diminishing ability to accurately predict the future?
What is Allstate doing about it?
In light of the increased risks posed by climate change, Allstate has responded by shying away from risk in its core homeowner’s insurance business in several ways:5
- Buying more reinsurance (insurance for insurers) for property most exposed to hurricanes
- Writing fewer new policies in coastal areas in the southern and eastern states
- Increasing deductibles (shifting risk to the consumer) in coastal areas
Outside of its core business operations, Allstate has implemented several initiatives regarding general corporate sustainability. The company has a Sustainability Leadership Committee, who are spearheading an emissions reduction goal within the organization focused on paper consumption and energy usage, as well as general employee education on sustainability.6 Allstate has also increased transparency regarding organizational views on climate change, working with Ceres and CDP, two non-profit organizations that work with corporations on sustainability initiatives.7
Should Allstate be doing more?
Given insurers are in the business of taking risk, it is a bit unsettling to see Allstate shying away from risk, which has implications for its bottom line, as well as for society.
Let’s first acknowledge the obvious: climate change is a large and difficult to understand risk. Allstate’s current posturing is understandable, given climate change is a risk that Allstate is not used to bearing. However, given Allstate is a market leader, it is well-positioned to invest in a better understanding of how climate change is going to impact homeowner’s policies in the medium to long term, and use this to gain market share. An in-house capability to price climate change risk would be a valuable differentiator and a barrier to entry in the homeowners insurance market.
Further, insurers provide an essential service to society, pooling risk to shield individuals from catastrophic losses. For any risk in the world, there is a party that must bear the risk. So if insurers aren’t bearing a particular risk, it means that individuals are. If not motivated by bottom line implications, Allstate should partner with other leaders in the homeowners insurance space to figure out how to collectively underwrite climate change risk to shield individuals from possible catastrophic losses.
So, are we in good hands?
Homeowners insurers, like all insurers, are most successful in a predictable world. The value of their experience is substantial, and allows more accurate pricing of risk. Climate change will inevitably impact homeowner’s insurers’ ability to accurately price risk. However, given the likelihood of more severe weather patterns, we need insurers to step up to the plate more than ever. Rather than sticking to known areas of comfort and profitability, we need insurers who are willing and able to tackle the problem of underwriting the massive risk of climate change, both for their own bottom line, and for the good of society. (723 words)
[1] Allstate, Form 10-K (filed May 24, 2016
[2] Ibid
[3] Ibid
[4] “Climate Change Indicators in the United States, 2014” U.S. Environmental Protection Agency, 3rd, 2014. p. 9
[5] Climate Change 2015 Information Request Allstate Corporation, http://corporateresponsibility.allstate.com/wp-content/uploads/2016/06/ALL_CR14_CDP_2015_Climate_Change_Disclosure.pdf
[6] Ibid
[7] Ibid
I love the use of insurance companies as a proof point for climate change. Unlike politics and everyday life in which people never have to put their money where their mouth is, insurance is literally the business of doing just that.
However, there is a misalignment of incentives here. Like all problems with long-term consequences, corporations’ short-term focus could cause these insurers to fundamentally misprice climate change risk. By understating the risk of climate change, insurers can offer lower prices in the short term and gain market share vs. those that are adequately or overestimating the risk. Over the tenure of the current CEO, this could look great for the bottom line while continuing to kick the risk can down the road. Of course, this sets the company up for some difficult times once the effects of climate change start to worsen and the mispriced policies start having to pay out.
Given the actions you have stated above, it would seem that Allstate may believe they are correctly pricing the risk, but that a significant portion of the rest of the value chain (potential customers and reinsurers) does not, making their policies look too expensive. The alternatives are avoiding writing the insurance, as you stated above, and ceding market share to insurers who do undervalue the risk, or biting the bullet and taking a lower margin. If a reinsurer believes the risk is lower, then Allstate can make up some of that perceived margin loss by arbitraging the risk with that party, leading again to a behavior you state above. Higher deductibles, too, can limit the impact of writing less-profitable insurance.
I’m with Michael Michael on how funny it is the way people act toward climate change when their money is on the line. In this case, All State, as you’ve pointed out, is straight up suspending homeowner’s insurance in coastal areas.
I think an additional solution to the problem you’ve raised may be an active partnership with the federal government. This issue has been coming up in a several coastal jurisdictions in the United States over the past year, and it seems in response the government has gradually been trying to mandate insurance companies to provide insurance to riskier markets or incentivize them to do so because right now, the way the system has been in these newly high-risk markets has been that either the insurance company doesn’t have money to back their claims so they ask the FEMA to bail them out or the homeowner never had a claim to begin with so they ask FEMA to bail them out. The federal government doesn’t want to be left with the bill and neither does the insurance company nor homeowner. Some collaboration between the private marketplace and government assistance will probably be most optimal because there will be increasing social costs to natural disasters caused by climate change if we don’t have quick, effective ways to quickly rebuild afterwards. Policies with federal partnerships might also be able to incentivize people to rebuild homes outside of flood zones, though that may get tricky as the entire east coast turns into a flood zone.
http://www.marketplace.org/2016/01/12/world/lawmakers-consider-flood-insurance-rules-0
http://www.marketplace.org/2016/08/17/world/why-more-louisiana-homeowners-lack-flood-insurance
http://www.marketplace.org/2016/08/18/sustainability/flood-insurance
I guess I’m not really surprised by the three things that Allstate is currently doing to mitigate against potential unknown future risks posed by climate change. But, to your point, their business is exactly that – understanding and pricing risk. If they are going to sell less and less insurance to coastal homeowners, it could create a difficult situation for both consumers / homeowners and the U.S. government in the event of future catastrophic events. It will be interesting to see if and how other players will fill the market void going forward.